Factbox: Key political risks to watch in Mexico

MEXICO CITY Wed Jul 4, 2012 7:25pm EDT

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MEXICO CITY (Reuters) - Opposition front-runner Enrique Pena Nieto won last Sunday's presidential election as expected, but he emerged with a narrower margin than had been forecast, complicating his chances of pushing through reforms.

Following are the main political risks to watch in Mexico.

ELECTION

Pena Nieto, the new face of the Institutional Revolutionary Party, or PRI, won more than 38 percent of the vote, about 6.5 percentage points ahead of his nearest rival, leftist Andres Manuel Lopez Obrador.

The result was good enough to restore to power the party that governed Mexico from 1929 to 2000 but Pena Nieto fell short of the double-digit victory projected in opinion polls. The PRI also failed to capture a congressional majority.

Lopez Obrador has yet to concede and threatened to challenge the outcome, saying the election was "plagued with irregularities." Such a challenge could be a nuisance to Pena Nieto, possibly denying him formal recognition as the winner from Mexico's Electoral Institute.

Lopez Obrador, a former Mexico City mayor and one of the founders of the leftist Party of the Democratic Revolution (PRD), contested the results six years ago when he lost by half a percentage point to Felipe Calderon of the National Action Party (PAN) and staged demonstrations that shut parts of the capital for weeks.

Lopez Obrador has yet to announce his intentions. While he lost by a less than 250,000 votes six years ago, this time he is more than 3 million votes behind, which could sap energy from any protests.

PAN candidate Josefina Vazquez Mota finished a distant third but the PAN is seen as likely to cooperate with the PRI in Congress to support Pena Nieto initiatives such as loosening the labor market and improving the tax take.

Pena Nieto and Calderon have both expressed willingness to work together once the new Congress convenes on September 1, three months before the new president is sworn in on December 1.

If they agree on reform measures, the PRI and the PAN together would have better than two-thirds of both the Senate and the lower house of Congress. That would allow them to even make constitutional changes and potentially allow greater foreign investment in the oil industry, currently a monopoly of the state-controlled company Pemex.

What to watch:

- Whether Lopez Obrador formally challenges the election outcome.

- Popular appetite for staging any demonstrations.

- The PAN's willingness to work with the PRI on reforms.

DRUG WAR

Pena Nieto has said his priority is to reduce the violence that has soared since Calderon launched a frontal assault on drug cartels soon after taking office in late 2006, with more than 55,000 people killed since then.

Drug cartels have lashed out against the government and each other, demonstrating barbaric violence such as stringing up victims from bridges, dumping headless bodies in piles and displaying severed heads on stakes.

Critics have speculated Pena Nieto might look to strike a deal with drug cartels but in his victory speech on election night he ruled out any negotiations or truce.

Financial markets are not spooked by the decapitations and day-time shootouts, but worries about the impact on investment and tourism persist.

What to watch:

- Whether drug-related violence spikes or wanes post-election.

- The new government's approach in tackling the cartels.

- U.S. reaction or any changes in cross-border strategy to fight drug gangs.

ECONOMY

Economists see the election as having little impact on this year's growth outlook, with those surveyed by the central bank last month expecting growth of 3.72 percent for Latin America's second biggest economy.

Growth accelerated more than expected in the first quarter but recent data have been more subdued and a surprise contraction in the U.S. manufacturing sector in June sparked concerns about the health of Mexico's main export market.

Although inflation has jumped above the 4 percent upper limit of the central bank's comfort zone, experts generally believe price pressures are contained despite a weak currency potentially pushing up the cost of imported goods.

Fears that Europe's debt woes could spark another global financial crisis pushed the peso to a more than three-year low in early June as investors fled riskier assets.

Sharp drops in the peso triggered dollar auctions several times in May under a mechanism that kicks in when the peso falls more than 2 percent in a single session.

The central bank held rates steady at 4.5 percent at its last policy meeting and moved firmly to a neutral stance, abandoning previous flirting with lower interest rates.

Despite volatility in the peso, which is used widely as a hedge for emerging market risk, foreign investment in Mexican bonds has continued to climb, reaching record highs in mid-June.

What to watch:

- Change in central bank interest rate policy.

- Signs of capital flight from bond markets.

- Ad hoc intervention in currency markets.

OIL WORRIES

Mexico's lumbering state oil monopoly Pemex has managed to stabilize oil production after a sharp decline at its largest fields between 2004 and 2009.

The government admits oil output will stagnate at around 2.8 million barrels per day (bpd) for the next 14 years without significant new investment in the sector.

The world's No. 7 oil producer now imports about 40 percent of its gasoline and risks becoming a net oil importer if it fails to improve production trends.

The government has pinned its hopes on a 2008 energy reform that made the first steps toward opening the state-run industry to more private investment.

The first incentive-based oil operating contracts were awarded late last year for small, mature fields, but oil majors are waiting for a promised round of more lucrative projects in Mexico's resource-rich deep waters in the Gulf of Mexico.

Pena Nieto and the PAN both say Pemex reforms must go much further and have pointed to the success of Brazil's state-owned Petrobras as a model. It trades shares on the stock exchange and has managed to boost efficiency and returns.

Past proposals for more radical changes to the oil sector - nationalized since 1938 - were blocked by the PRD and some PRI lawmakers.

Mexico has long been reliant on oil revenues to fund the federal budget, putting government finances at risk if prices drop. Even when oil prices are high, Pemex regularly runs at a loss as the government takes the bulk of its revenues in taxes.

What to watch:

- Foreign companies' interest in new contracts.

- Details on oil reform proposals post-election.

(Editing by Kieran Murray and Bill Trott)

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